(Extracted from A Man for All Markets by Ed Thorp)
The defect of VaR alone is that it doesn’t fully account for the worst 5 percent of expected cases. But these extreme events are where ruin is to be found. It’s also true that extreme changes in securities prices may be much greater than you would expect from the Gaussian or normal statistics commonly used. When the S&P 500 Index fell 23 percent on October 19, 1987, a leading academic finance professor said that if the market had traded every day for the thirteen-billion-year life of the universe, the chance of this happening even once was negligible.